Trial and Settlement: A Study of High-Low Agreements

J.J. Prescott, Kathryn E. Spier, Albert Yoon

NBER Working Paper No. 19873
Issued in March 2014
NBER Program(s):The Law and Economics Program

This paper presents the first systematic theoretical and empirical study of high-low agreements in civil litigation. A high-low agreement is a private contract that, if signed by litigants before the conclusion of a trial, constrains any plaintiff recovery to a specified range. Whereas existing work describes litigation as a choice between trial and settlement, our examination of high-low agreements--an increasingly popular phenomenon in civil litigation--introduces partial or incomplete settlements. In our theoretical model, trial is both costly and risky. When litigants have divergent subjective beliefs and are mutually optimistic about their trial prospects, cases may fail to settle. In these cases, high-low agreements can be in litigants' mutual interest because they limit the risk of outlier awards while still allowing an optimal degree of speculation. Using claims data from a national insurance company, we describe the features of these agreements and empirically investigate the factors that may influence whether litigants discuss or enter into them. Our empirical findings are consistent with the predictions of the theoretical model. We also explore extensions and alternative explanations for high-low agreements, including their use to mitigate excessive, offsetting trial expenditures and the role that negotiation costs might play. Other applications include the use of collars in mergers and acquisitions.

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Document Object Identifier (DOI): 10.3386/w19873

Published: J.J. Prescott & Kathryn E. Spier & Albert Yoon, 2014. "Trial and Settlement: A Study of High-Low Agreements," The Journal of Law and Economics, vol 57(3), pages 699-746.

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